Dealpolitik: The Unseen Perils of the Poison Pill

Air Products’ $5.9 billion takeover bid for Airgas will reach a new climax next week. A Delaware judge will decide who gets the final say on the tender offer: shareholders or the board.

The corporate constituency is, of course, cheering for Airgas. If you don’t want your company taken over, you want a ruling that directors can decide to “just say no” and leave a poison pill in place forever, thereby precluding shareholders from choosing to take the money and run. Or that is what they think they want.

If the judge sides with Airgas—and most commentators think he will—the reaction of institutional investors to a strengthening of corporate legal defenses could actually make future targets more vulnerable.

The Legal Issue. The legal issue in the case is simple and straightforward. The standard was pretty much fully developed in the 1980s. If a board of directors reasonably thinks a takeover is a threat to a corporation, it can take proportionate action to defend the company against that threat. And that can include adopting or retaining a poison pill. The Airgas board has had a few missteps, but on the whole it seems to be developing a record to support its position that Airgas is and will be worth more than the Air Products’ offer of $70 a share.

The Governance Revolution. Those 1980s legal standards, however, were developed in a wholly different environment. The takeover threat was from corporate raiders and hostile bidders. Institutional investors back then were not activists—it was not gentlemanly. Besides, if you were an institution and made trouble, you might lose some of your access to management. If a court said the institutions had no rights to make the decision on a cash tender, then they understood that as part of the rules of the game.

The institutions have totally changed in the last 25 years. By and large they are not averse to flexing their muscle. They’re not afraid to withhold votes from the election of directors they don’t like, or to whom they want to send a message. And with majority voting— a concept which was unheard of in the 1980s—such withhold votes have the potential to defeat directors in board elections.

Institutions can increase the pressure with even more aggressive tactics–including seeking to replace directors. Just look at what Calstrs wrote to Occidental Petroleum on governance issues last summer, or the plans Calpers has to take advantage of the coming proxy access regulations. Moreover, ISS/RiskMetrics now has a huge influence on shareholder voting. This results in the threat being amplified if the directors take governance positions that violate ISS policies.

And the ground is shaking further under the feet of corporate management with three words: “say on pay.” Periodic shareholder votes on executive compensation are now the law. Of course, they are only advisory, and compensation committees are legally free to ignore a “no” vote on executive compensation. But if you were a CEO and your compensation were determined by an independent board committee, would you be willing to risk you wouldn’t have to pay for such a “no” vote for years to come?

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So when institutions and ISS gang up on governance issues they really feel passionately about—and making money tends to be a pretty passionate issue—a threat to vote no on “say on pay” will pretty much be the nuclear option.

Life could be miserable for those companies that refuse to commit not to take advantage of a show-stopping defensive tactic, even if that tactic is court-endorsed.

Be Careful What You Wish For. Turning back to the Airgas case, let’s suppose this court (or if appealed, the Delaware Supreme Court) allows the board to “just say no” on the Air Products takeover.

If the Airgas board is right and the stock price shortly rises to exceed Air Product’s $70 bid or if Airgas can do some financial engineering to produce that kind of value—such as a leveraged recap or leveraged buyout—then the community will say “well done” to the board.

But the market right now says Airgas is worth around $62.40 per share. If the price goes down when Air Products walks and stays down, the arbitrage community will take a huge hit. Other institutions will see their opportunity for future premium bids for other companys being sharply diminished.

It is hard to see institutions in 2011 standing still for such a prospect in future deals, even if they are stuck with it for Airgas. Staggered boards—which are the key to defeating these bids as they protect a majority of management directors from removal for two annual election cycles— and poison pills are already unpopular with institutions and ISS. If staggered boards now mean a board can use a poison pill to prevent shareholders from selling into an offer for an entire year even though no alternatives surface, I think we will hear institutions and ISS making their displeasure known.

They will, in my view, pressure boards heavily to commit not use the staggered board/poison pill duo to permanently eliminate shareholder choice on cash deals at a big premium. And with the ultimate nuclear option of “say on pay” voting, they have the tools to cause managements to buckle. A win for a takeover defense might be a Pyrrhic victory.

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Ronald Barusch spent more than 30 years as an M&A practitioner at Skadden, Arps, Slate, Meagher & Flom LLP before retiring this year. He is no longer affiliated with the firm and the views expressed here are his own.

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